Private equity real estate funds are becoming more and more popular in the last few years, but they're not exactly new. Real estate syndications have existed for decades, with some of the earliest examples dating back to 1926.
Real estate funds come in two different flavors: REITs (Real Estate Investment Trust) and private investments. Private investment funds allow you to invest alongside a small group of other investors, while REITs offer publicly traded stocks that represent an ownership stake in a larger pool of properties around the world.
Commercial real estate has always been considered an "alternative investment," but it is fast becoming more mainstream. With housing prices skyrocketing, the increasing cost of raw components and lumber, and labor shortages, the idea of owning a piece of income property is just not in the cards anymore for many individuals. So, most investors are turning toward small multifamily or other hands-off type commercial real estate properties.
Aside from buying an entire storage facility or small multifamily complex on your own, another more affordable entry point into commercial real estate can be found through real estate investment funds. These funds appeal to investors who want to own commercial property but would rather be passive in their investing approach, meaning they do not want to directly partake in property management activities.
Investors pool money to purchase assets within the fund. The fund's sponsor then directs all of the fund's operations, including property management. If the fund purchases and renovates or buys and holds property for an extended duration of time, the sponsor team will need to make stronger efforts in property management. Real estate funds are a fantastic strategy for individuals who want to generate passive income by investing in real estate, but don't want to be responsible for the property.
What Is A Real Estate Fund?
Real estate funds are a mutual investment entity. Mutual investments allow investors to invest any amount of money they choose toward numerous properties at the same time, regardless of the property-to-capital ratio. This way, investors circumvent the need to have the entire capital amount that would be required to invest in whole properties as an individual. Investors can purchase a portion of several properties in the form of shares.
Real estate investment funds provide you the chance to invest in real properties with a variety of rules and regulations that are specific to each region. There are different kinds of funds, including dividend-paying real estate investment funds, which are similar to mutual funds. These funds combine money from investors and give them the opportunity to explore Investors may choose from a wide variety of funds, each with its own targets.
Rules for each real estate fund vary. But generally, the funds offer investors the chance to invest in real estate at a lower price point, maintain liquidity since shares can be cashed out early, and, of course, the opportunity to earn passive income when rent is paid on the properties and when the value of the real estate increases.
Types of Real Estate Funds
As you look deeper into real estate funds, you will notice two main types of real estate funds. The first type is a private equity real estate fund. Private equity funds are not open to the public and have more restrictive membership criteria, such as high net worth or an institutional affiliation.
The second type is a Real Estate Investment Trust (REIT). Real estate investment trusts are publicly traded. Although there is a cost to the investor, REIT's offer liquidity and can provide diversification within your portfolio.
How To Invest In Private Equity Real Estate Funds
Once you connect with a firm or sponsor who is offering an investment opportunity, you have a couple of choices as to how you can invest your capital. You can either send in capital you've saved in a highly accessible account or you can invest using your retirement savings.
Wire Liquid Funds
If you've saved your investment capital in a highly-accessible, highly liquid savings or other bank account, you can simply wire the entire investment amount to the sponsor, according to the instructions provided in the investment documentation. The sponsor will then buy shares in the fund on your behalf and list them in an account that is maintained at the transfer agent.
Self-Directed IRA Funds
The self-directed IRA is one of the most popular ways to access real estate investment funds. This version of an IRA isn't much different from a Roth IRA. Self-directed IRAs are more popular because they allow investors to invest in a wider range of assets, such as real estate investment funds.
Traditionally, brokerages do not allow investors to invest money in non-traditional investment possibilities from a Roth IRA, Traditional IRA, or 401K. As a result, investors interested in a real estate fund strategy may need to transfer funds from their existing, likely traditional brokerage account to an IRA custodian that offers self-directed investing choices.
The main benefit of investing in a real estate fund instead of buying and managing an investment property is it allows the investor to diversify their portfolio and still keep a hands-off approach. Investors should remember that self-directed IRAs are self-directed, which means it is 100% up to the individual to do their research and conduct thorough due diligence, find good sponsors, and explore potential opportunities and risks prior to investing in any fund or other alternative investment.
Benefits of Investing in Real Estate Funds
Real estate funds often provide higher than average, consistent returns, that are independent from the stock market’s fluctuations, further proving that investing in real estate is a dependable way to generate revenue and profits over time. Real estate investing allows you to diversify your portfolio instead of having all of your eggs in one basket like with buying an investment property or stock market investments alone.
Investing in real estate funds also gives you access to the real estate market without the hassle of being a property owner or manager. You can pick and choose from different types of real estate investments without having to do all the research yourself - the fund's sponsor will have already done that for you.
Diversification
You combine your money with other investors' to buy a set of similarly rated assets in different locations using real estate funds. You may also diversify your holdings by purchasing shares in multiple funds. You can even diversify across asset types, markets, and appreciation profiles by buying shares in different funds. Diversification lowers risk while increasing the potential for greater returns for investors.
Profitability
Most real estate investment funds are designed to pay investors back before the fund's sponsor makes any money. As a result, the sponsor is under great pressure to ensure that the transaction meets its intended profit goal. The structure of investments is designed to maintain the interests of the sponsor and their investors in alignment.
Tax Efficiency
Most funds are structured to last longer than one year, meaning they will be taxed as long-term capital gains instead of short-term. Real estate funds also allow you to invest in real estate without worrying about depreciation.
Investors may benefit from pass-through depreciation, and the tax benefits will rest on the investor’s shoulders and be driven by their circumstances. Real estate funds offer investors a way to defer taxes on their share of income and capital gains until they actually sell their shares in the fund.
Preferred Returns
When it comes to preferred return, the investor is paid first. If it's a cash flow fund, investors will receive their distributions throughout the life of the investment. This sort of return is necessary because you'll be paid before the professional manager, which is crucial when dealing with higher-risk assets.
Will Your Next Real Estate Investment Be in a Fund?
Not all funds are created equal, and you always want to do your research and due diligence before investing in a particular real estate fund. Be sure to vet the fund’s sponsor, management team, and explore the fund’s track record.
Evaluate the fund’s targeted returns, then determine if you believe in or agree with their strategy and how long it will take to hit their target metrics.
As with any investment, research the opportunity thoroughly. No investment comes without risk, and no investment is foolproof. The more you know about how the fund is structured, the team running it, and the assets that are inside the fund, the more likely you are to invest your hard-earned money in a profit-making machine!
At Three Keys Investments, we’re experienced in working with investors at all experience levels, and truly believe that when you watch out for and respect your money, it takes care of you back.
We invite you to join our Investor Club, because we love talking about this stuff! A fully informed investor (like you) is more likely to make the right investment decisions and easily hit your financial milestones (maybe even faster than expected).
This work by Annie Dickerson is licensed under CC BY-NC-SA 4.0
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